Financing the Short Term Obligations of The Business - Coursework Example

Financing The Short Term Obligations Of A Business” and Task Sources of Short Term Finance There are many different types of sources of short term finance that can be used by a company to finance its operations. However, the most common sources include: (i) business overdrafts, (ii) trade credit, (iii) bank loans, and (iv) lease. Each of these is discussed in detail below. I. Business Overdraft Almost all companies have the accounts with more than one bank. An overdraft facility is when the bank agrees that company withdraws money from the bank in excess of its balance with the bank.

Of course, such a facility needs to be agreed with the bank well in advance, so that the bank honors its commitment by allowing an overdraft facility to the company at a time when the company’s own funds end. A major difference between a loan and an overdraft is that in loans, interest is to be paid on the entire amount, whereas in the case of an overdraft interest is only paid on the amount of overdraft facility used (and not on the entire amount of overdraft facility). II. Trade Credit Trade credit is often a facility extended by suppliers to their customers to make payment at a later then at the actual time of making the purchase.

The payment can be made by the company anytime within the time decided at the time of making the purchase. Trade credit facilities are usually lent out by suppliers without charging any interest on the amount of purchase as such. The payment period varies from company to company, but most businesses are required to pay up within a month of making the purchase. III. Bank Loans Bank loans are one of the most common ways of financing the short term obligations of a company. Money can be lent from banks on flexible terms in terms of the repayment period, amount of the loan and that interest that would be charged on the principal amount (Webster and Healey, 1998).

Bank loans are a very good way to finance the operations of a company but the downside is high interest payments, which need to be paid even if the business itself doesn’t do well enough (Organization For Economic Cooperation And Development, 1996). IV. Lease Leasing is one of the most common ways of financing the operations of a company. Even though leasing doesn’t allow one to own a particular thing, it effectively gives the owner of the lease a right to use the good leased. In case of a lease pre-decided payments need to be made at every payment interval and they give the lessee the right to use the goods as they want to.

Leasing is a good source of short term financing as it gives the right to use the goods leased just by making small term payments rather than buying the good outright. Moreover, leases are flexible and can be set up to suit a company’s own requirements. Task 2 The two companies that are being used for the purpose of this question are British Petroleum and Shell. a) Shell has been financing its short term obligations with the help of liquid cash. Moreover, the company has access to various international capital markets from where it can raise debts to service its obligations.

It has access to these debt capital markets through the help of two commercial paper or CP programs, namely the EMTN program (Euro Medium Term Note Program) and the US universal shelf registration. Moreover, Shell also has access to a committed credit facility, which it often used to service its short term obligations. British Petroleum, on the other hand, uses cash to service its short term obligations. Other than that, it has lending and overdraft facilities set up with commercial banks, which it uses at times for the same purpose (Nichols, 1908).

Moreover, to manage its exposure to risk on its short term liabilities, British Petroleum also engages in the trading of derivatives. b) Liquidity And Efficiency Ratios Shell British Petroleum Liquidity Ratios Current Ratio = Current Assets / Current Liabilities 112,894 / 100,552 = 1.12 89,725 / 82,832 = 1.08 Quick Ratio = (Current Assets – Stock) / Current Liabilities (112,894 – 29,348) / 100,552 = 0.83 (89,725 – 26,218) / 82,832 = 0.77 Efficiciency Ratios Debtor Days = (Debtors / Sales) * 365 70,102 * 365 / 368,056 = 69.

52 days 36,549 * 365 / 297,107 = 44.9 days Creditor Days = (Creditors / Purchases) * 365 76,550 * 365 / 283,176 = 98.67 days 46,329 * 365 / 216,211 = 78.21 days Stock Turnover Days = Cost Of Goods Sold / Average Stock (27,410 + 283,176 – 29,348) / ((27,410 + 29,348) / 2) = 9.91 times (22,605 + 216,211 – 26,218) / ((22605 + 26,218) / 2) = 8.71 times c) Liquidity Ratios The liquidity position of Shell seems to be slightly better off than of its competitor, British Petroleum. Shell has a current ratio of 1.

12, meaning it 1.12 units of assets to serve every 1 unit of its liability. On the other hand, the same figure for British Petroleum stands at 1.08, which isn’t that bad as per industry standards, yet is a little lower than its competitor Shell (Nichols, 1908). Quick ratio is the same as current ratio besides the fact that it doesn’t take stock into consideration as a current asset. The rationale behind this is that stock often takes a lot of time to be sold, thereby it isn’t that liquid.

Shell has a better quick ratio than British Petroleum. However, since the figure for both the companies is below 1, it means that the company is not in a current state to finance all its short term liabilities with the help of its current assets since a lot of money is tied up in inventory (Nichols, 1908). d) Efficiency Ratios Looking at the efficiency ratios makes it very clear the Shell is more efficient in managing its working capital as compared to Shell. British Petroleum makes recovery from its debtors in about 45 days as compared to Shell, which takes almost 70 days to do the same.

This much a considerable amount of money is stuck with debtors all the time until the payment is actually received (Webster and Healey, 1998). Credit days for Shell and British Petroleum stand at 99 and 78 days respectively. It can be observed here that Shell better negotiates with it suppliers, as it is able to get a longer deadline to make payment to its suppliers. This mean that in the meanwhile until payment is made to the suppliers (Keir, 1988), Shell can use this money to finance other business related issues.

Finally, the stock turnover days for Shell and British Petroleum are 9.9 and 8.7 respectively. Shell has higher stock turnover days which mean it is better at managing its stock. Shell generates a higher level of sales from its ordered stock then British Petroleum does, thereby saving on holding and ordering costs of stocks and maximizing profitability. Appendix Shell’s Statement of Comprehensive Income Shell’s Statement of Financial Position British Petroleum’s Statement of Comprehensive Income British Petroleum’s Statement of Financial Position References Top of Form ETZKOWITZ, H.

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Happersett. Top of Form DUN & BRADSTREET CREDIT SERVICES, & DUN & BRADSTREET CORPORATION. (1989). Industry norms and key business ratios, one year. [Murray Hill, N.J.], Dun & Bradstreet Credit Services. Top of Form KEIR, M. (1988). The oil industry. London, B.T. Batsford. Bottom of Form Top of Form NICHOLS, A. G. (1908). The Oil industry. Bottom of Form Top of Form ORGANISATION FOR ECONOMIC CO-OPERATION AND DEVELOPMENT. (1996). Industry productivity: international comparison and measurement issues.

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